For the last three or so months, our China lawyers have been confronted with a host of legal issues related to the coronavirus. This should not be surprising because China was the seminal coronavirus epicenter. For the past two months or so, our Seattle lawyers have been working on a host of legal issues related to the coronavirus. This too should not be surprising because Seattle is the United States’ coronavirus epicenter. For the past month or so, all this has become true for our Spain lawyers as well, as Spain too became an epicenter and last week went into a full lockdown. Our California and Oregon lawyers have also in the past few months been hit with a slew of coronavirus related legal matters.
The coronavirus does not discriminate, though sadly, people do. See Do Not Blame Chinese People for the Coronavirus. No Exceptions. The coronavirus has and will continue to impacts all societies and economies and this has meant our law firm has been seeing and dealing with the same sort of legal issues in all the countries in which we work. This sameness of legal issues around the world has led us to create a cross-border legal team out of the United States, China and Spain to assist companies with their legal issues arising from or related to the coronavirus. This multi-disciplinary and multi-jurisdictional team is using the knowledge and experience our lawyers have gained in one jurisdiction to determine best practices in the other jurisdictions.
In this series of posts, we have been discussing the legal issues our lawyers in China, the United States, and Spain have been confronting, with the goal of making this blog a repository of information on coronavirus law and especially on how to handle legal matters that have arisen due to the coronavirus.
In Part 1, we focused on employment law issues because those were the first issues we saw and those are the issues that continue to arise most often due to the coronavirus. In this Part 2, we look at the second most common issue we have been seeing arise from the coronavirus: force majeure. In fact, our deep experience with this issue has already led our lawyers to be interviewed and quoted on force majeure in this Economist article, this Financial Times article, and this Corporate Counsel article and in Spanish in this EuropaPress article and in this Cinco Días article.
The force majeure issues we have been handling and seeing in the last few weeks in the United States and in Spain have to a large extent tracked those we started getting months ago involving China. Below we discuss a complicated and yet common supply chain force majeure issue that involves both China and the United States so as to highlight the importance in all force majeure cases of trying to resolve them before they become a long and expensive loser take all lawsuit.
In the face of the COVID-19 pandemic, the breakdown in the global supply chain has become even more severe. At one point, the issue was confined to imports from factories in China. Now the issue has become global. As a global issue, the impact is felt by all players in the global system: factories that make things, importers that import those things, and retailers that sell those things.
Many of our clients are American (both North, Central and South), European, and Australian companies that stand in the middle of this now broken global supply chain. Our clients import products made in China and in other countries, like Vietnam, Thailand, Turkey, Malaysia and Mexico. Our clients then sell their products to wholesale and retail customers in their own countries, and often times globally as well. As the supply chain breaks, the importer is in a difficult position.
Consider the difficulty and take China as an example. The U.S. importer has a contract with a Chinese factory. But the importer also has a contract with a U.S. customer. At the start of the COVID-19 pandemic, the concern of the importer was direct. The importer is required to sell to the U.S. customer on a confirmed contract: either a long term purchase agreement or one or more confirmed purchase orders. But due to China’s long COVID-19 lockdown, this U.S. importer’s Chinese factory cannot produce any product. So the importer is unable to meet its contractual obligation to its U.S. customer and is therefore in default.
The legal issue is then whether the U.S. importer can escape liability for its default by claiming its failure to supply is a force majeure event. Under force majeure principles, the importer is not liable if its inability to perform is due to an event that a) is not within its control and b) was not foreseeable. In China, it is generally understood that COVID-19 in China qualifies as a force majeure event.
But under U.S. law, the situation is not that simple. Unlike China and most civil law countries, the U.S. does not have a general law of force majeure. In China, the contract law has a built in provision concerning impossibility of performance. But in the U.S., the issue is normally addressed largely by analyzing of what the applicable contract provides on the force majeure issue. In the case of the U.S. importer, this then results in an impossibly complex situation. A court would be required to examine: a) the facts of the outbreak in China and its impact on the Chinese factory, b) the contractual relationship between the Chinese factory and the importer and c) the contract between the U.S. importer and the customer.
The situation in the U.S. has become even more complex. In the standard analysis, the customer wants the product. The importer cannot provide the product and the customer makes a claim for breach. But in the current situation, the opposite may be true. The importer has made heroic efforts to obtain the product by having made additional payments to its Chinese factory to jump ahead of the Chinese factory’s other buyers. Or maybe the importer spent large sums of money to move its production out of China so as to be certain to get its U.S. customer the product. But now that the importer has jumped through one or more expensive hoops to get the product to the United States, its customer no longer wants the product because coronavirus lockdowns in the United States has eliminated demand. Say you are providing a product for sale in a smart phone accessories retail chain. But that chain has shut down. Or you are providing items used in the restaurant, bar or hotel industry. But that industry is shut down. Being shut down, they have no need for your product. Even worse, they do not know when they will be back up and running.
This situation can then lead to a cascade of defaults where force majeure principles could plausibly be used as a defense in four settings: a) importer against foreign factory default, b) foreign factory against importer default, c) U.S. customer against importer default, d) importer against customer default. In this cascade of defaults, lawsuits and defenses, the importer is stuck in the middle.
So what is to be done? In our experience once the lawsuits begin, the importer in the middle suffers the most. For this reason, the strategy for the importer should be to take action NOW, with the goal of preventing the cascade of defaults from starting and of preparing a legal defense that will mitigate legal liability if the prevention work does not fully succeed.
The first step is for the importer to review all its agreements. This should include its contracts, purchase orders, sales plans and estimates. The first thing to consider is whether the contract specifically deals with force majeure and, if so, how. Some contracts do not deal with the issue at all. For contracts in most civil law countries like China (and most other countries in the world), impossibility of performance usually addresses the issue. In the U.S., there are a full range of possibilities. Some contracts will have pages dealing with specific rules on dealing with force majeure. Some will have a single “bolerplate” paragraph. Some distribution arrangements are done on a handshake and say nothing. Other sales arrangements are based on a bare purchase order that may or may not be formally accepted.
The purpose of this first step is to determine whether there are any required procedures in place that must be followed. For example, in many cases, if force majeure will be used as a defense, the party invoking force majeure must provide immediate notice and a mitigation plan must be adopted. If these rules apply, they must be followed or any later force majeure defense very well might be deemed ineffective. For the importer, this analysis is complex. The importer may have numerous foreign factories and numerous customers. The importer must determine where it stands with all the players and then must assess its liability with respect to each.
The second step is to develop a plan NOW to communicate with all the players. Based on our experience in these situations, once the cascade of defaults and lawsuits starts, it is too late for the importer to save the situation. The importer must get ahead of the situation and fight against the tendency of all parties to “freeze up” and stop communicating, in the belief that if we don’t discuss it nobody will notice it. This is a natural response; the parties hope the situation will just go away. But this approach almost invariably fails. The approach with by far the best chance of working is for the importer to take action.
The basic action plan should usually be as follows:
- Assess the situation. Will the factory provide product? Don’t rely on a vague statement from the factory that it will do so because that is just not good enough in this sort of situation. Insist on a specific delivery date and seek to avoid having to make any payments until the delivery is made. If the factory will not provide a hard delivery date, assume no delivery will be made. Do the same assessment with your customers. Do they still want the product? Will there be a delay? If there will be a delay, how long? What about payments, now or in the future?
- Make a plan that involves communicating with all parties. In a global pandemic situation like that of COVID-19, the analysis will almost certainly reveal problems. Take immediate action to communicate with the parties involved to work out a plan to deal with these problems. If the factory will delay delivery of the product the importer cannot deliver that product to its customer and it should contact that customer immediately to develop a plan to deal with the situation. If the customer does not want to take delivery, it should work with both the customer and the factory to develop an alternative plan.
In the planning phase, some players will be cooperative and some will not. One of the goals of the planning phase is to find this out. For the cooperative player, work constructively to develop a plan. For the resistant players, work to develop a legal plan that protects your interests and those of the other parties that will be impacted. In either case, it is critical that you document your plan and then closely monitor all relevant events and revise your plan as conditions change.
The ultimate key when you are involved in any force majeure situation, be it one involving a global supply chain or your restaurant lease in Seattle, Washington or Madrid, Spain, is not to become a passive victim of the COVID-19 pandemic. Get out in front of the issue. Face the reality of the situation, assess your contractual and factual situation and make a plan that can solve or alleviate the problems and then implement that plan.